form10q2011nov4.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549


FORM 10-Q


(Mark One)
 
  [X]  
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
     
For the Quarterly Period Ended September 30, 2011

OR

  [ ]  
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
     
For the transition period from _____ to _____


Commission file number 1-5153

Marathon Oil Corporation
(Exact name of registrant as specified in its charter)

Delaware
25-0996816
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
5555 San Felipe Road, Houston, TX  77056-2723
(Address of principal executive offices)

(713) 629-6600
(Registrant’s telephone number, including area code)


 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.                          Yes    ü   No           
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of
 
Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).   Yes       ü      No           

 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.  See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer      ü   
Accelerated filer           
Non-accelerated filer                (Do not check if a smaller reporting company) 
Smaller reporting company            
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).                                     Yes            No     ü   
 
There were 703,721,720 shares of Marathon Oil Corporation common stock outstanding as of October 31, 2011.
 



 
 
 


MARATHON OIL CORPORATION
Form 10-Q
Quarter Ended September 30, 2011


 
INDEX
   
   
Page
 
PART I - FINANCIAL INFORMATION
 
Item 1.
Financial Statements:
     
      2  
      3  
      4  
      5  
      6  
      7  
Item 2.
    23  
Item 3.
    36  
Item 4.
    36  
      37  
PART II - OTHER INFORMATION
 
Item 1.
    39  
Item 1A.
    39  
Item 2.
    40  
Item 6.
    41  
      42  

 
Unless the context otherwise indicates, references in this Form 10-Q to “Marathon Oil,” “we,” “our,” or “us” are references to Marathon Oil Corporation, including its wholly-owned and majority-owned subsidiaries, and its ownership interests in equity method investees (corporate entities, partnerships, limited liability companies and other ventures over which Marathon Oil exerts significant influence by virtue of its ownership interest).  Any reference to “Marathon” indicates Marathon Oil Corporation as it existed prior to the June 30, 2011 spin-off of the downstream business.
 
 
 
1
Part I - Financial Information
Item 1. Financial Statements

MARATHON OIL CORPORATION
 
Consolidated Statements of Income (Unaudited)
 

 
 
Three Months Ended
   
Nine Months Ended
 
 
 
September 30,
   
September 30,
 
(In millions, except per share data)
 
2011
   
2010
   
2011
   
2010
 
Revenues and other income:
 
 
   
 
   
 
   
 
 
 
 
 
   
 
   
 
   
 
 
   Sales and other operating revenues
  $ 3,633     $ 2,839     $ 10,969     $ 8,287  
   Sales to related parties
    16       15       45       41  
   Income from equity method investments
    123       77       360       245  
   Net gain on disposal of assets
    13       -       63       822  
   Other income
    14       24       36       52  
 
                               
             Total revenues and other income
    3,799       2,955       11,473       9,447  
Costs and expenses:
                               
   Cost of revenues (excludes items below)
    1,600       1,107       4,671       3,384  
   Purchases from related parties
    57       57       184       132  
   Depreciation, depletion and amortization
    517       530       1,716       1,376  
   Impairments
    -       -       307       439  
   General and administrative expenses
    104       108       371       328  
   Other taxes
    59       44       170       145  
   Exploration expenses
    129       59       504       282  
 
                               
            Total costs and expenses
    2,466       1,905       7,923       6,086  
 
                               
Income from operations
    1,333       1,050       3,550       3,361  
 
                               
   Net interest and other
    (30 )     (16 )     (62 )     (53 )
   Loss on early extinguishment of debt
    -       -       (279 )     (92 )
 
                               
Income from continuing operations before income taxes
    1,303       1,034       3,209       3,216  
 
                               
   Provision for income taxes
    898       567       2,051       1,758  
 
                               
Income from continuing operations
    405       467       1,158       1,458  
 
                               
   Discontinued operations
    -       229       1,239       404  
 
                               
Net income
  $ 405     $ 696     $ 2,397     $ 1,862  
 
                               
Per Share Data
                               
 
                               
   Basic:
                               
 
                               
       Income from continuing operations
  $ 0.57     $ 0.66     $ 1.63     $ 2.06  
       Discontinued operations
  $ -     $ 0.32     $ 1.74     $ 0.57  
       Net income per share
  $ 0.57     $ 0.98     $ 3.37     $ 2.63  
 
                               
   Diluted:
                               
 
                               
       Income from continuing operations
  $ 0.57     $ 0.66     $ 1.62     $ 2.05  
       Discontinued operations
  $ -     $ 0.32     $ 1.73     $ 0.57  
       Net income per share
  $ 0.57     $ 0.98     $ 3.35     $ 2.62  
 
                               
   Dividends paid
  $ 0.15     $ 0.25     $ 0.65     $ 0.74  
 
                               
   Weighted average shares:
                               
       Basic
    711       710       712       709  
       Diluted
    714       712       716       711  
 
 
The accompanying notes are an integral part of these consolidated financial statements.

 
2
 
MARATHON OIL CORPORATION
Consolidated Statements of Comprehensive Income (Unaudited)
 

 
 
Three Months Ended
   
Nine Months Ended
 
 
 
September 30,
   
September 30,
 
(In millions)
 
2011
   
2010
   
2011
   
2010
 
Net income
  $ 405     $ 696     $ 2,397     $ 1,862  
    Other comprehensive income
                               
 
                               
         Post-retirement and post-employment plans
                               
            Change in actuarial gain (loss)
    13       (24 )     110       134  
            Spin-off downstream business
    -       -       968       -  
            Income tax benefit  (provision) on post-retirement and
                               
               post-employment plans
    6       10       (409 )     (73 )
                  Post-retirement and post-employment plans, net of tax
    19       (14 )     669       61  
 
                               
         Derivative hedges
                               
            Net unrecognized gain (loss)
    (1 )     1       9       5  
            Spin-off downstream business
    -       -       (7 )     -  
            Income tax benefit (provision) on derivatives
    -       0       (1 )     -  
                  Derivative hedges, net of tax
    (1 )     1       1       5  
 
                               
         Foreign currency translation and other
                               
            Unrealized gain (loss)
    -       (1 )     (1 )     (1 )
            Income tax provision on foreign currency translation and other
    -       1       -       1  
                  Foreign currency translation and other, net of tax
    -       -       (1 )     -  
 
                               
Other comprehensive income
    18       (13 )     669       66  
 
                               
Comprehensive income
  $ 423     $ 683     $ 3,066     $ 1,928  
 
 
The accompanying notes are an integral part of these consolidated financial statements.

 
3
 
MARATHON OIL CORPORATION
Consolidated Balance Sheets (Unaudited)

 
     
December 31,
 
(In millions, except per share data)
 
2011
   
2010
 
Assets
 
 
   
 
 
Current assets:
 
 
   
 
 
    Cash and cash equivalents
  $ 4,633     $ 3,951  
    Receivables, less allowance for doubtful accounts of $2 and $7
    1,696       5,972  
    Receivables from related parties
    25       58  
    Inventories
    342       3,453  
    Other current assets
    458       395  
 
               
            Total current assets
    7,154       13,829  
 
               
Equity method investments
    1,431       1,802  
Property, plant and equipment, less accumulated depreciation,
               
   depletion and amortization of $16,731 and $19,805
    20,318       32,222  
Goodwill
    537       1,380  
Other noncurrent assets
    1,101       781  
 
               
            Total assets
  $ 30,541     $ 50,014  
Liabilities
               
Current liabilities:
               
    Accounts payable
  $ 1,548     $ 8,000  
    Payables to related parties
    14       49  
    Payroll and benefits payable
    129       418  
    Accrued taxes
    1,904       1,447  
    Deferred income taxes
    -       324  
    Other current liabilities
    192       580  
    Long-term debt due within one year
    338       295  
 
               
            Total current liabilities
    4,125       11,113  
 
               
Long-term debt
    4,705       7,601  
Deferred income taxes
    2,676       3,569  
Defined benefit postretirement plan obligations
    667       2,171  
Asset retirement obligations
    1,337       1,354  
Deferred credits and other liabilities
    275       435  
 
               
            Total liabilities
    13,785       26,243  
 
               
Commitments and contingencies
               
 
               
Stockholders’ Equity
               
Preferred stock – no shares issued and outstanding (no par value, 26 million shares
               
          authorized)
    -       -  
Common stock:
               
     Issued –  770 million and  770 million shares  (par value $1 per share,
               
          1.1 billion shares authorized)
    770       770  
     Securities exchangeable into common stock – no shares issued and outstanding
               
         (no par value, 29 million shares authorized)
    -       -  
     Held in treasury, at cost – 66 million and 60 million shares
    (2,721 )     (2,665 )
Additional paid-in capital
    6,675       6,756  
Retained earnings
    12,352       19,907  
Accumulated other comprehensive loss
    (328 )     (997 )
Noncontrolling interest
    8       -  
            Total stockholders' equity
    16,756       23,771  
 
               
            Total liabilities and stockholders' equity
  $ 30,541     $ 50,014  
 
 
The accompanying notes are an integral part of these consolidated financial statements.

 
4
 
MARATHON OIL CORPORATION
Consolidated Statements of Cash Flows (Unaudited)

 
 
Nine Months Ended
 
 
 
September 30,
 
(In millions)
 
2011
   
2010
 
Increase (decrease) in cash and cash equivalents
 
 
   
 
 
Operating activities:
 
 
   
 
 
Net income
  $ 2,397     $ 1,862  
Adjustments to reconcile net income to net cash provided by operating activities:
               
    Loss on early extinguishment of debt
    279       92  
    Discontinued operations
    (1,239 )     (404 )
    Deferred income taxes
    (75 )     (411 )
    Depreciation, depletion and amortization
    1,716       1,376  
    Impairments
    307       439  
    Pension and other postretirement benefits, net
    28       (39 )
    Exploratory dry well costs and unproved property impairments
    311       122  
    Net gain on disposal of assets
    (63 )     (822 )
    Equity method investments, net
    16       34  
    Changes in:
               
          Current receivables
    202       (124 )
          Inventories
    47       (35 )
          Current accounts payable and accrued liabilities
    361       924  
    All other operating, net
    113       85  
               Net cash provided by continuing operations
    4,400       3,099  
               Net cash provided by (used in) discontinued operations
    1,090       (111 )
               Net cash provided by operating activities
    5,490       2,988  
Investing activities:
               
   Additions to property, plant and equipment
    (2,437 )     (2,703 )
   Disposal of assets
    385       1,354  
   Investments - repayments of loans and return of capital
    41       35  
   Investing activities of discontinued operations
    (493 )     (920 )
   Property deposit
    (120 )     -  
   All other investing, net
    13       (22 )
               Net cash used in investing activities
    (2,611 )     (2,256 )
Financing activities:
               
   Debt repayments
    (2,843 )     (620 )
   Purchases of common stock
    (300 )     -  
   Dividends paid
    (462 )     (526 )
   Financing activities of discontinued operations
    2,916       (8 )
   Distribution in Spin-off
    (1,622 )     -  
   All other financing, net
    129       8  
               Net cash used in financing activities
    (2,182 )     (1,146 )
Effect of exchange rate changes on cash
    (15 )     -  
Net increase (decrease) in cash and cash equivalents
    682       (414 )
Cash and cash equivalents at beginning of period
    3,951       2,057  
Cash and cash equivalents at end of period
  $ 4,633     $ 1,643  
 
 
The accompanying notes are an integral part of these consolidated financial statements.

 
5
 
MARATHON OIL CORPORATION
Consolidated Statement of Stockholders’ Equity (Unaudited)
 

(In millions)
 
Preferred Stock
   
Common Stock
   
Securities Exchangeable for Common Stock
   
Treasury Stock
   
Additional Paid-in Capital
   
Retained Earnings
   
Accumulated Other Comprehensive Income (Loss)
   
Non-controlling Interest
   
Total Stockholders' Equity
 
December 31, 2010 Balance
  $ -     $ 770     $ -     $ (2,665 )   $ 6,756     $ 19,907     $ (997 )   $ -     $ 23,771  
 Shares issued - stock
                                                                       
     based compensation
    -       -       -       251       (84 )     -       -               167  
   Shares repurchased
    -       -       -       (307 )     -       -       -               (307 )
   Stock-based compensation
    -       -       -       -       (2 )     -       -               (2 )
   Net income
    -       -       -       -       -       2,397       -               2,397  
   Other comprehensive income
    -       -       -       -       -       -       82               82  
   Dividends paid
    -       -       -       -       -       (462 )     -               (462 )
   Purchase of subsidiary shares
                                                                       
      from noncontrolling interest
    -       -       -       -       -       -       -       8       8  
   Spin-off of downstream
                                                                       
      business
    -       -       -       -       5       (9,490 )     587               (8,898 )
September 30, 2011 Balance
  $ -     $ 770     $ -     $ (2,721 )   $ 6,675     $ 12,352     $ (328 )   $ 8     $ 16,756  
 
(Shares in millions)
 
Preferred Stock
   
Common Stock
   
Securities Exchangeable for Common Stock
   
Treasury Stock
                                         
December 31, 2010 Balance
    -       770       -       (60 )                                        
 Shares issued - stock
                                                                       
     based compensation
    -       -       -       6                                          
   Shares repurchased
    -       -       -       (12 )                                        
September 30, 2011 Balance
    -       770       -       (66 )                                        
 
 
The accompanying notes are an integral part of these consolidated financial statements.

 
6
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
 

1.      Basis of Presentation
 
These consolidated financial statements are unaudited; however, in the opinion of management, these statements reflect all adjustments necessary for a fair statement of the results for the periods reported.  All such adjustments are of a normal recurring nature unless disclosed otherwise.  These consolidated financial statements, including notes, have been prepared in accordance with the applicable rules of the Securities and Exchange Commission and do not include all of the information and disclosures required by accounting principles generally accepted in the United States of America for complete financial statements.
 
 
As a result of the spin-off (see Note 2), the results of operations for our downstream (Refining, Marketing and Transportation) business have been classified as discontinued operations for all periods presented.  The disclosures in this report are presented on the basis of continuing operations, unless otherwise stated. Any reference to “Marathon” indicates Marathon Oil Corporation as it existed prior to the June 30, 2011 spin-off.
 
 
These interim financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Marathon Oil Corporation 2010 Annual Report on Form 10-K.  The results of operations for the quarter and nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for the full year.
 

2.      Spin-off Downstream Business
 
On June 30, 2011, the spin-off of the downstream (Refining, Marketing and Transportation) business was completed, creating two independent energy companies: Marathon Oil Corporation (“Marathon Oil”) and Marathon Petroleum Corporation (“MPC”).  On June 30, 2011, stockholders of record as of 5:00 p.m. Eastern Daylight Savings time on June 27, 2011 (the “Record Date”) received one common share of MPC stock for every two common shares of Marathon stock held as of the Record Date.
 
 
 In order to affect the spin-off and govern our relationship with MPC after the spin-off, we entered into a Separation and Distribution Agreement, a Tax Sharing Agreement, an Employee Matters Agreement and a Transition Services Agreement.  The Separation and Distribution Agreement governed the separation of the downstream business, the distribution of MPC’s shares of common stock to our stockholders, transfer of assets and intellectual property, and other matters related to our relationship with MPC.  The Separation and Distribution Agreement provides for cross-indemnities between Marathon Oil and MPC.  In general, we have agreed to indemnify MPC for any liabilities relating to our historical oil and gas exploration and production operations, oil sands mining operations and integrated gas operations, and MPC has agreed to indemnify us for any liabilities relating to the historical downstream operations.
 
 
The Tax Sharing Agreement governs the respective rights, responsibilities and obligations of Marathon Oil and MPC with respect to taxes and tax benefits, the filing of tax returns, the control of audits and other tax matters.  In addition, the Tax Sharing Agreement reflects each company’s rights and obligations related to taxes that are attributable to periods prior to and including the Separation date and taxes resulting from transactions effected in connection with the Separation. In general, under the Tax Sharing Agreement, Marathon Oil is responsible for all U.S. federal, state, local and foreign income taxes attributable to Marathon Oil or any of its subsidiaries for any tax period that begins after the date of the spin-off, and MPC is responsible for all taxes attributable to it or its subsidiaries, whether accruing before, on or after the spin-off.  The Tax Sharing Agreement contains covenants intended to protect the tax-free status of the spin-off.  These covenants may restrict the ability of Marathon Oil and MPC to pursue strategic or other transactions that otherwise could maximize the values of their respective businesses and may discourage or delay a change of control of either company.
 
 
The Employee Matters Agreement contains provisions concerning benefit protection for employees who become MPC employees prior to December 31, 2011, treatment of holders of Marathon stock options, stock appreciation rights, restricted stock and restricted stock units, and cooperation between Marathon Oil and MPC in the sharing of employee information and maintenance of confidentiality.  Unvested equity-based compensation awards were converted to awards of the entity where the employee holding them is working post-separation.  For vested equity-based compensation awards, employees received both Marathon Oil and MPC awards.
 
 
Under the Transition Services Agreement, Marathon Oil and MPC are providing and/or making available various administrative services and assets to each other, for up to a one-year period beginning on the distribution date of the spin-off.  The services include: administrative services; accounting services; audit services; health, environmental and safety services; human resource services; information technology services; legal services; natural gas administration services; tax services; and treasury services.  In consideration for such services, the companies are paying fees to the other for the services provided, and these fees are generally in amounts intended to allow the party providing services to recover all of its direct and indirect costs incurred in providing these services.
 

 
7
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
 
 
The following table presents the carrying value of assets and liabilities of MPC, immediately preceding the spin-off, which is excluded from the Marathon Oil consolidated balance sheet as a result of the spin-off on June 30, 2011.
 
(In millions)
 
 
 
Current assets:
     
Cash and cash equivalents
  $ 1,622  
Receivables
    5,041  
Inventories
    3,679  
Other current assets
    170  
Total current assets of discontinued operations
    10,512  
Equity method investments
    323  
Property, plant and equipment
    11,935  
Goodwill
    847  
Other noncurrent assets
    351  
Total assets of discontinued operations
  $ 23,968  
         
Current liabilities:
       
Accounts payable
  $ 7,329  
Payroll and benefits payable
    222  
Accrued and deferred taxes
    443  
Other current liabilities
    461  
Long-term debt due within one year
    12  
Total current liabilities of discontinued operations
    8,467  
Long-term debt
    3,262  
Deferred income taxes
    1,576  
Defined benefit postretirement plan obligations
    1,489  
Deferred credits and other liabilities
    276  
Total liabilities of discontinued operations
  $ 15,070  
 
The following table presents selected financial information regarding the results of operations of our downstream business which are reported as discontinued operations.  Transaction costs incurred to affect the spin-off of $74 million are included in discontinued operations for 2011.
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
September 30,
   
September 30,
 
(In millions)
2011
 
2010
 
2011
 
2010
 
Revenues applicable to discontinued operations
  $ -     $ 15,897     $ 38,602     $ 45,054  
Pretax income from discontinued operations
    -       445       2,012       693  

3.      Accounting Standards
 
Not Yet Adopted
 
 
In September 2011, the Financial Accounting Standards Board (“FASB”) amended accounting standards to simplify how entities test goodwill for impairment.  The amendments reduce complexity by allowing an entity the option to make a qualitative evaluation of whether it is necessary to perform the two-step goodwill impairment test.  The amendment is effective for our interim and annual periods beginning with the first quarter of 2012.  Early adoption is permitted, but we were unable to do so because our 2011 annual goodwill impairment testing was completed prior to the issuance of the amendment.  Adoption of this amendment will not have a significant impact on our consolidated results of operations, financial position or cash flows.
 
 
The FASB amended the reporting standards for comprehensive income in June 2011 to eliminate the option to present the components of other comprehensive income as part of the statement of changes in stockholders' equity.  All non-owner changes in stockholders’ equity are required to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements.  In the two statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income.  The presentation of items that are reclassified from other comprehensive income to net on the income statement is also required.  The amendments did not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income.  The

 
8
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
 

amendments are effective for us beginning with the first quarter of 2012.  We are still evaluating this reporting standard, but we do not expect adoption of this amendment to have an impact on our consolidated results of operations, financial position or cash flows.
 
 
In May 2011, the FASB issued an update amending the accounting standards for fair value measurement and disclosure, resulting in common principles and requirements under U.S. generally accepted accounting principles (“U.S. GAAP”) and International Financial Reporting Standards (“IFRS”).  The amendments change the wording used to describe certain of the U.S. GAAP requirements either to clarify the intent of existing requirements, to change measurement or expand disclosure principles or to conform to the wording used in IFRS.  The amendments are to be applied prospectively and will be effective for our interim and annual periods beginning with the first quarter of 2012.  Early application is not permitted.  We do not expect adoption of these amendments to have a significant impact on our consolidated results of operations, financial position or cash flows.
 
 
4.      Variable Interest Entities
 
 
The Athabasca Oil Sands Project (“AOSP”), in which we hold a 20 percent undivided interest, contracted with a wholly-owned subsidiary of a publicly traded Canadian limited partnership (“Corridor Pipeline”) to provide materials transportation capabilities among the Muskeg River and Jackpine mines, the Scotford upgrader and markets in Edmonton.  The contract, originally signed in 1999 by a company we acquired, allows each holder of an undivided interest in the AOSP to ship materials in accordance with its undivided interest.  Costs under this contract are accrued and recorded on a monthly basis, with a $3 million current liability recorded at September 30, 2011.  Under this agreement, the AOSP absorbs all of the operating and capital costs of the pipeline.  Currently, no third-party shippers use the pipeline.  Should shipments be suspended, by choice or due to force majeure, we remain responsible for the portion of the payments related to our undivided interest for all remaining periods.  The contract expires in 2029; however, the shippers can extend its term perpetually.  This contract qualifies as a variable interest contractual arrangement and the Corridor Pipeline qualifies as a Variable Interest Entity (“VIE”).  We hold a variable interest but are not the primary beneficiary because our shipments are only 20 percent of the total; therefore, the Corridor Pipeline is not consolidated by Marathon Oil.  Our maximum exposure to loss as a result of our involvement with this VIE is the amount we expect to pay over the contract term, which was $696 million as of September 30, 2011.  The liability on our books related to this contract at any given time will reflect amounts due for the immediately previous month’s activity, which is substantially less than the maximum exposure over the contract term.  We have not provided financial assistance to Corridor Pipeline and we do not have any guarantees of such assistance in the future.
 

5.      Income per Common Share
 
Basic income per share is based on the weighted average number of common shares outstanding.  Diluted income per share includes exercise of stock options and stock appreciation rights, provided the effect is not antidilutive.
 
   
Three Months Ended September 30,
 
   
2011
   
2010
 
(In millions, except per share data)
 
Basic
   
Diluted
   
Basic
   
Diluted
 
               
Income from continuing operations
  $ 405     $ 405     $ 467     $ 467  
Discontinued operations
    -       -       229       229  
Net income
  $ 405     $ 405     $ 696     $ 696  
                                 
Weighted average common shares outstanding
    711       711       710       710  
Effect of dilutive securities
    -       3       -       2  
Weighted average common shares, including
                               
     dilutive effect
    711       714       710       712  
                                 
Per share:
                               
    Income from continuing operations
  $ 0.57     $ 0.57     $ 0.66     $ 0.66  
    Discontinued operations
  $ -     $ -     $ 0.32     $ 0.32  
    Net income
  $ 0.57     $ 0.57     $ 0.98     $ 0.98  
 
 
9
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)

   
Nine Months Ended September 30,
 
   
2011
   
2010
 
(In millions, except per share data)
 
Basic
   
Diluted
   
Basic
   
Diluted
 
               
Income from continuing operations
  $ 1,158     $ 1,158     $ 1,458     $ 1,458  
Discontinued operations
    1,239       1,239       404       404  
Net income
  $ 2,397     $ 2,397     $ 1,862     $ 1,862  
                                 
Weighted average common shares outstanding
    712       712       709       709  
Effect of dilutive securities
    -       4       -       2  
Weighted average common shares, including
                               
     dilutive effect
    712       716       709       711  
                                 
Per share:
                               
    Income from continuing operations
  $ 1.63     $ 1.62     $ 2.06     $ 2.05  
    Discontinued operations
  $ 1.74     $ 1.73     $ 0.57     $ 0.57  
    Net income
  $ 3.37     $ 3.35     $ 2.63     $ 2.62  
 
The per share calculations above exclude 9 million and 7 million stock options and stock appreciation rights for the third quarter and the first nine months of 2011, as they were antidilutive.  Excluded in the third quarter and the first nine months of 2010 were 12 million stock options and stock appreciation rights.
 
6.      Acquisitions
 
During the first nine months of 2011, we acquired approximately 45,000 net acres in the Eagle Ford shale formation in south Texas for approximately $202 million.  This was funded from existing cash and was accounted for as an asset acquisition.
 
Early in the fourth quarter, we closed on the following transactions in Eagle Ford: the previously announced 141,000 net acres from Hilcorp Resources Holdings, LP (“Hilcorp”); additional interests of approximately 19,000 acres net acres; and a gas gathering system.  Also, during the fourth quarter, we expect to close on an additional 6,800 net acres in Eagle Ford from tag-along rights.  The total acquisition cost for these nearly 167,000 net acres and the gathering system is expected to be approximately $4.5 billion, including projected closing adjustments and future carrying costs.  These transactions will be funded largely from existing cash.  The acreage includes proved and unproved oil and gas assets, as well as some producing wells.  We are in the process of evaluating the acquisitions to determine whether they will be accounted for as business combinations or as asset acquisitions.
 
 7.      Dispositions
 
During the third quarter of 2011, we sold our Integrated Gas segment’s equity interest in a liquefied natural gas (“LNG”) processing facility in Alaska.  A gain on the transaction of $8 million was recorded in the third quarter.
 
In April 2011, we assigned a 30 percent undivided working interest in our Exploration and Production (“E&P”) segment’s approximately 180,000 acres in the Niobrara shale play located within the DJ Basin of southeast Wyoming and northern Colorado for total consideration of $270 million, recording a pretax gain of $37 million.  We remain operator of this jointly owned leasehold.
 
Also in April 2011, we farmed-out a 40 percent working interest in 10 concessions in our E&P segment’s Poland’s Paleozoic Shale play.  In late July 2011, we sold an additional 9 percent working interest. A $12 million pretax gain was recorded.  We currently hold a 51 percent working interest in these 10 concessions and serve as operator.
 
In March 2011, we closed the sale of our E&P segment's outside-operated interests in the Gudrun field development and the Brynhild and Eirin exploration areas offshore Norway for net proceeds of $85 million, excluding working capital adjustments.  A $64 million pretax loss on this disposition was recorded in the fourth quarter 2010.
 
During the first quarter 2010, we closed the sale of a 20 percent outside-operated interest in our E&P segment’s Production Sharing Contract and Joint Operating Agreement in Block 32 offshore Angola.  We received net proceeds of $1.3 billion and recorded a pretax gain on the sale in the amount of $811 million.  We retained a 10 percent outside-operated interest in Block 32.
 
Pending disposition
 
In October 2011, we entered into definitive agreements to sell our E&P segment’s equity interests in several Gulf of Mexico crude oil pipeline systems including our 28 percent interest in Poseidon Oil Pipeline Company, L.L.C., our 29 percent interest in Odyssey Pipeline L.L.C., our 23 percent interest in the Eugene Island Pipeline System, and certain other oil pipeline interests. The value of this transaction, subject to further closing adjustments, is approximately $206
 
10
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
 

million, net of debt.  In addition, the Poseidon and Odyssey interests are subject to wavier of rights of first refusal.  The carrying value of these assets was $45 million as of September 30, 2011.  We expect to close the transaction in the fourth quarter of 2011.
 

8.      Segment Information
 
We have three reportable operating segments.  Each of these segments is organized and managed based upon the nature of the products and services they offer.
 
 
 
1)
Exploration and Production (“E&P”) – explores for, produces and markets liquid hydrocarbons and natural gas on a worldwide basis;
 
 
 
2)
Oil Sands Mining (“OSM”) – mines, extracts and transports bitumen from oil sands deposits in Alberta, Canada, and upgrades the bitumen to produce and market synthetic crude oil and vacuum gas oil; and
 
 
 
3)
Integrated Gas (“IG”) – markets and transports products manufactured from natural gas, such as liquefied natural gas (“LNG”) and methanol, on a worldwide basis.
 
 
Segment income represents income from continuing operations, net of income taxes, attributable to the operating segments. Our corporate general and administrative costs are not allocated to the operating segments. These costs primarily consist of employment costs (including pension effects), professional services, facilities and other costs associated with corporate activities, net of associated income tax effects.  Foreign currency remeasurement and transaction gains or losses are not allocated to operating segments.
 
 
Differences between segment totals for income taxes, depreciation, depletion and amortization and income from equity method investments and our consolidated totals represent amounts related to corporate administrative activities and other unallocated items which are included in “Items not allocated to segments, net of income taxes” in the reconciliation below. Capital expenditures include accruals.
 
 
As discussed in Notes 1 and 2, our downstream business was spun-off on June 30, 2011 and has been reported as discontinued operations in all periods presented.
 
   
Three Months Ended September 30, 2011
 
(In millions)
 
E&P
   
OSM
   
IG
   
Total
 
                         
Revenues:
                       
    Customer
  $ 3,190     $ 427     $ 16     $ 3,633  
    Intersegment
    6       -       -       6  
    Related parties
    16       -       -       16  
        Segment revenues
    3,212       427       16       3,655  
    Elimination of intersegment revenues
    (6 )     -       -       (6 )
        Total revenues
  $ 3,206     $ 427     $ 16     $ 3,649  
Segment income
  $ 330     $ 92     $ 55     $ 477  
Income from equity method investments
    63       -       60       123  
Depreciation, depletion and amortization
    454       55       -       509  
Income tax provision
    890       31       19       940  
Capital expenditures
    684       36       1       721  
 
 

 
11
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
 
 
 
   
Three Months Ended September 30, 2010
 
(In millions)
 
E&P
   
OSM
   
IG
   
Total
 
                         
Revenues:
                       
    Customer
  $ 2,605     $ 196     $ 38     $ 2,839  
    Intersegment
    20       -       -       20  
    Related parties
    15       -       -       15  
        Segment revenues
    2,640       196       38       2,874  
    Elimination of intersegment revenues
    (20 )     -       -       (20 )
        Total revenues
  $ 2,620     $ 196     $ 38     $ 2,854  
Segment income
  $ 510     $ 18     $ 41     $ 569  
Income from equity method investments
    51       -       51       102  
Depreciation, depletion and amortization
    491       28       1       520  
Income tax provision
    579       2       21       602  
Capital expenditures
    586       191       1       778  

   
Nine Months Ended September 30, 2011
 
(In millions)
 
E&P
   
OSM
   
IG
   
Total
 
                         
Revenues:
                       
    Customer
  $ 9,696     $ 1,180     $ 93     $ 10,969  
    Intersegment
    47       -       -       47  
    Related parties
    45       -       -       45  
        Segment revenues
    9,788       1,180       93       11,061  
    Elimination of intersegment revenues
    (47 )     -       -       (47 )
        Total revenues
  $ 9,741     $ 1,180     $ 93     $ 11,014  
Segment income
  $ 1,599     $ 193     $ 158     $ 1,950  
Income from equity method investments
    187       -       173       360  
Depreciation, depletion and amortization
    1,541       141       3       1,685  
Income tax provision
    2,101       64       62       2,227  
Capital expenditures
    2,101       236       2       2,339  

   
Nine Months Ended September 30, 2010
 
(In millions)
 
E&P
   
OSM
   
IG
   
Total
 
                         
Revenues:
                       
    Customer
  $ 7,622     $ 567     $ 98     $ 8,287  
    Intersegment
    49       -       -       49  
    Related parties
    41       -       -       41  
        Segment revenues
    7,712       567       98       8,377  
    Elimination of intersegment revenues
    (49 )     -       -       (49 )
        Total revenues
  $ 7,663     $ 567     $ 98     $ 8,328  
Segment income (loss)
  $ 1,444     $ (59 )   $ 109     $ 1,494  
Income from equity method investments
    128       -       142       270  
Depreciation, depletion and amortization
    1,279       67       3       1,349  
Income tax provision (benefit)
    1,741       (15 )     56       1,782  
Capital expenditures
    1,774       699       2       2,475  

 
12
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
 
 
The following reconciles segment income to net income as reported in the consolidated statements of income:
 
   
Three Months Ended
   
Nine Months Ended
 
   
September 30,
   
September 30,
 
(In millions)
 
2011
   
2010
   
2011
   
2010
 
Segment income
  $ 477     $ 569     $ 1,950     $ 1,494  
Items not allocated to segments, net of income taxes:
                               
     Corporate and other unallocated items
    (79 )     (50 )     (215 )     (130 )
     Foreign currency remeasurement of income taxes
    23       (37 )     6       33  
     Impairments(a)
    -       (15 )     (195 )     (286 )
     Loss on early extinguishment of debt(b)
    -       -       (176 )     (57 )
     Tax effect of subsidiary restructuring(c)
    -       -       (122 )     -  
     Deferred income tax items(c)
    (15 )     -       (65 )     (45 )
     Water abatement - Oil Sands(d)
    -       -       (48 )     -  
     Gain on dispositions (e)
    (1 )     -       23       449  
         Income from continuing operations
    405       467       1,158       1,458  
         Discontinued operations
    -       229       1,239       404  
               Net income
  $ 405     $ 696     $ 2,397     $ 1,862  
 
(a)
Impairments are discussed in Note 13.
(b)
Additional information on debt retired early can be found in Note 15.
(c)
Changes in deferred taxes and the non cash tax restructuring are discussed in Note 10.
(d)
Oil sands water abatement costs are discussed in Note 19.
 (e)
Additional information on these gains can be found in Note 7.
 
The following reconciles total revenues to sales and other operating revenues as reported in the consolidated statements of income:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
(In millions)
2011
   
2010
 
2011
 
2010
 
Total revenues
  $ 3,649     $ 2,854     $ 11,014     $ 8,328  
Less:  Sales to related parties
    16       15       45       41  
    Sales and other operating revenues
  $ 3,633     $ 2,839     $ 10,969     $ 8,287  

 
9.      Defined Benefit Postretirement Plans
 
The following summarizes the components of net periodic benefit cost related to continuing operations:
 
   
Three Months Ended September 30,
 
  
 
Pension Benefits
   
Other Benefits
 
(In millions)
 
2011
   
2010
   
2011
   
2010
 
Service cost
  $ 12     $ 12     $ 1     $ -  
Interest cost
    17       17       4       4  
Expected return on plan assets
    (16 )     (16 )     -       -  
Amortization:
                               
    – prior service cost (credit)
    1       2       (2 )     (2 )
    – actuarial loss
    12       12       -       -  
    – net settlement
    -       8       -       -  
Net periodic benefit cost
  $ 26     $ 35     $ 3     $ 2  
 
 
13
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
 

   
Nine Months Ended September 30,
 
  
 
Pension Benefits
   
Other Benefits
 
(In millions)
 
2011
   
2010
   
2011
   
2010
 
Service cost
  $ 35     $ 35     $ 3     $ 2  
Interest cost
    50       52       12       12  
Expected return on plan assets
    (49 )     (48 )     -       -  
Amortization:
                               
    – prior service cost (credit)
    4       5       (5 )     (5 )
    – actuarial loss
    37       37       -       -  
    – net settlement/curtailment loss
    -       8       -       -  
Net periodic benefit cost
  $ 77     $ 89     $ 10     $ 9  
 
During the first nine months of 2011, we made contributions related to continuing operations of $43 million to our funded pension plans.  We expect to make additional contributions up to an estimated $13 million to our funded pension plans over the remainder of 2011, most of which were made in October 2011.  Current benefit payments related to unfunded pension and other postretirement benefit plans of our continuing operations were $4 million and $14 million during the first nine months of 2011.
 

10.           Income Taxes
 
The following is an analysis of the effective income tax rates for continuing operations for the periods presented:
 
   
Nine Months Ended September 30,
 
   
2011
   
2010
 
Statutory U.S. income tax rate
    35 %     35 %
Effects of foreign operations, including foreign tax credits
    7       19  
Change in permanent reinvestment assertion
    7       -  
Adjustments to valuation allowances
    11       -  
Tax law changes
    2       2  
Other tax effects
    2       (1 )
        Effective income tax rate for continuing operations
    64 %     55 %
 
Effects of foreign operations
 
The effective income tax rate is influenced by a variety of factors including the geographic and functional sources of income, the relative magnitude of these sources of income, and foreign currency remeasurement effects.  The provision for income taxes is allocated on a discrete, stand-alone basis to pretax segment income and to individual items not allocated to segments.  The difference between the total provision and the sum of the amounts allocated to segments and to individual items not allocated to segments is reported in “Corporate and other unallocated items” shown in Note 8.
 
The effects of foreign operations on our effective tax rate decreased in the first nine months of 2011 as compared to the first nine months of 2010, primarily due to the suspension of all production operations in Libya in the first quarter of 2011, where the statutory tax rate is in excess of 90 percent.  This decrease was partially offset by a deferred tax charge of $122 million related to an internal restructuring of our international subsidiaries in the second quarter of 2011.
 
Change in permanent reinvestment assertion
 
A principal tax planning strategy available to realize the deferred tax asset for our foreign tax credit benefits relates to the permanent reinvestment of our foreign subsidiaries’ earnings, which is reconsidered quarterly to give effect to changes in our portfolio of producing properties and in our tax profile. In the second quarter of 2011, we recorded $716 million of deferred U.S. tax on undistributed earnings of $2,046 million that we previously intended to permanently reinvest in foreign operations. Offsetting this tax expense were associated foreign tax credits of $488 million. In addition, we reduced our valuation allowance related to foreign tax credits by $228 million due to recognizing deferred U.S. tax on previously undistributed earnings.
 
Adjustments to valuation allowance
 
The ability to realize the benefit of foreign tax credits is based on certain estimates concerning future operating conditions (particularly as related to prevailing liquid hydrocarbon, natural gas and synthetic crude oil prices), future financial conditions, income generated from foreign sources and Marathon Oil's tax profile in the years that such credits may be claimed.  In the third quarter of 2011, we increased the valuation allowance against foreign tax credits by $227
 
14
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
 

million because it is more likely than not that we will be unable to realize all U.S. benefits on foreign taxes accrued in 2011.  A higher price and production outlook over the next several years for Norway due to better than expected performance contributed to our generating excess foreign tax credits.
 
 
During the second quarter of 2011, we recorded a valuation allowance of $18 million on our deferred tax assets related to state operating loss carryforwards.  Due to the spin-off (see Note 2), we have determined it is more likely than not that we will be unable to realize all recorded deferred tax assets.
 
 
Tax law changes
 
On July 19, 2011, the U.K. enacted Finance Bill 2011 which increased the rate of the supplementary charge levied on profits from U.K. oil and gas production from 20 percent to 32 percent, effective March 24, 2011.  As a result of this legislation, we recorded deferred tax expense of $15 million in the third quarter of 2011.
 
On May 25, 2011, Michigan enacted legislation that replaced the Michigan Business Tax (“MBT”) with a corporate income tax (“CIT”), effective January 1, 2012.  The new CIT legislation eliminates the “book-tax difference deduction” that was provided under the MBT to mitigate the net increase in a taxpayer’s deferred tax liability resulting when Michigan moved from the Single Business Tax, a non-income tax, to the MBT, an income tax, on July 12, 2007.  Such a change in the tax law must be recognized in earnings in the period enacted regardless of the effective date.  The total effect of tax law changes on deferred tax balances is recorded as income tax expense related to continuing operations in the period the law is enacted, even if a portion of the deferred tax balances relate to discontinued operations.  As a result of the new CIT legislation, we recorded an expense of $32 million in the second quarter of 2011.
 
 
The Patient Protection and Affordable Care Act (“PPACA”) and the Health Care and Education Reconciliation Act of 2010 (“HCERA”), (together, the “Acts”) were signed in to law in March 2010.  The Acts effectively change the tax treatment of federal subsidies paid to sponsors of retiree health benefit plans that provide prescription drug benefits that are at least actuarially equivalent to the corresponding benefits provided under Medicare Part D.  The federal subsidy paid to employers was introduced as part of the Medicare Prescription Drug, Improvement, and Modernization Act of 2003 (the “MPDIMA”).  Under the MPDIMA, the federal subsidy does not reduce our income tax deduction for the costs of providing such prescription drug plans nor is it subject to income tax individually.  Beginning in 2013, under the Acts, our income tax deduction for the costs of providing Medicare Part D-equivalent prescription drug benefits to retirees will be reduced by the amount of the federal subsidy.  Such a change in the tax law must be recognized in earnings in the period enacted regardless of the effective date.  The total effect of tax law changes on deferred tax balances is recorded as income tax expense related to continuing operations in the period the law is enacted, even if a portion of the deferred tax balances relate to discontinued operations.  As a result, we have recorded a charge of $45 million in the first quarter of 2010 for the write-off of deferred tax assets to reflect the change in the tax treatment of the federal subsidy.
 
 
The following table summarizes the activity in unrecognized tax benefits:
 
 
 
Nine Months Ended September 30,
 
(In millions)
 
2011
   
2010
 
Beginning balance
  $ 103     $ 75  
     Additions based on tax positions related to the current year
    3       4  
     Reductions based on tax positions related to the current year
    (3 )     (4 )
     Additions for tax positions of prior years
    71       16  
     Reductions for tax positions of prior years
    (24 )     (22 )
     Settlements
    (9 )     (1 )
Ending balance
  $ 141     $ 68  
 
If the unrecognized tax benefits as of September 30, 2011 were recognized, $90 million would affect our effective income tax rate.  There were $10 million of uncertain tax positions as of September 30, 2011 for which it is reasonably possible that the amount of unrecognized tax benefits would decrease during the next twelve months.
 

 
15
 
MARATHON OIL CORPORATION
Notes to Consolidated Financial Statements (Unaudited)
 

11.           Inventories
 
Inventories are carried at the lower of cost or market value.  The cost of inventories of crude oil, refined products and merchandise is determined primarily under the last-in, first-out (“LIFO”) method. A significant portion of our inventories were related to our downstream business (see Note 2) at December 31, 2010.
 
   
September 30,